For Vultures, Slim Pickings

Newspaper chain Lee Enterprises Inc.LEE0.00% is on the verge of saving itself from bankruptcy—and many of its debt holders are livid.

Lee, weighed down by about $1 billion of debt, has long been high on the list of potential bankruptcies. But thanks to the roaring market for debt of risky companies, Lee is preparing to sell junk bonds that would enable it to pay off its obligations and give it a new shot at survival.

But what is good news for the company has thwarted the plans of a flock of "vulture" investors—Monarch Alternative Capital, Alden Global Capital, Marblegate Asset Management and a unit of Goldman Sachs Group Inc.GS-1.03%—which have been buying Lee's loans. The group had been betting the company would default, and that they could turn their holdings into an ownership stake, giving them access to the company's assets, which include St. Louis Post Dispatch and the Arizona Daily Star newspapers.

ENLARGE

Instead, they will get repaid, but miss out on the chance to make even bigger profits as owners.

Lee isn't alone in its sudden pullback from the brink of bankruptcy, thanks to the frothy state of the high-yield bond market. One by one, distressed companies have been able to sell debt as money floods into the debt markets.

Radio broadcaster Emmis Communications Corp.EMMS-2.76% recently convinced lenders to extend its debt maturities after threatening to raise new money in the bond market, according to a person familiar with the matter. Energy Future Holdings Corp., laboring under debt taken on during its 2007 leveraged buyout, is in the market with a similar transaction this month.

That has left few money-making opportunities for distressed-debt investors, who engage in a type of financial schadenfreude: profiting from the misfortunes of others. Vulture investors typically buy debt at low prices, expecting to turn that debt into equity in the company, giving them ownership. Then they can sell off assets or run the company, making more money than they would by simply owning the debt.

"Everybody and their brother in the distressed market would like to see Lee default," said one distressed-debt fund manager who owns the company's loans.

Vulture funds had expected to feed for many years on the aftermath of the financial crisis, taking advantage of companies in deep distress. Instead, the liquidity pumped into capital markets by the Federal Reserve has enabled many of those companies to survive, driving down the U.S. corporate default rate to a low of 2.75% in March, according to Standard & Poor's.

In fact, many distressed portfolio mangers have been forced out of corporate-debt markets and have switched to buying troubled stocks or mortgage-backed bonds. Funds focused on distressed debt have generated returns of 2.75% for the first three months of this year, compared with 3.62% for hedge funds focused on asset-backed securities.

Lee's debt is about six times its earnings before interest, taxes, depreciation and amortization, and many believed the company wouldn't be able to raise financing to pay back its bank loans when they matured in April 2012.

Lee's demise looked so inevitable that some of the investors even conferred two months ago to discuss the most favorable ways to restructure the company, according to people familiar with the matter.

The funds accumulated most of their positions in 2010, when Lee's debt traded at a median price of 80 cents on the dollar. If the company refinances the loans, the funds will recover 100 cents on the dollar, a 25% return for those that bought in at last year's median.

The prospect that Lee might benefit from the junk-bond boom was too much to bear for fund managers at Alden Global. One manager there was so frustrated that he called Lee's bankers at Credit Suisse AG last month to berate them for sabotaging his plans, according to a person familiar with the matter. Alden declined to comment.

Lee incurred much of its debt in 2005 when it paid top-dollar to buy Pulitzer Inc., a chain of 14 newspapers including the St. Louis Post-Dispatch. The combined company would have been a particularly valued prize because, unlike many of the other publishers that went bankrupt in recent years, the company generates over $100 million of free cash flow despite its debt load. The publisher's focus—running small and midsize papers and keeping a rein on costs—has insulated it from the worst of the decline in subscriptions and advertising affecting newspapers in metropolitan markets.

One believer is Lee's largest shareholder, Ariel Investment Trust, which was founded by value investor John Rogers, who is also an economic adviser to President Barack Obama. After being forced to cut its holdings in Lee by two-thirds during the financial crisis, Ariel ramped up its investment in the past year and now owns a 20% stake.

"Management made a convincing argument that in individual small towns their papers' content is still extremely valuable," said Mr. Rogers. Lee Chief Executive Mary Junck "kept making the argument that eyeballs on their papers were actually growing, that's why we bought more and more on weakness," he said.

Lee shares are up 21% this year, closing on Friday at $2.97. While they are up from a low of 27 cents in March 2009, they are a fraction of their 2007 levels of almost $35. A Lee spokesman declined to comment.

Lee's determination to escape a fate that has befallen Tribune Co., MediaNews Group and the Journal Register Co.—all of which fell into the clutches of vulture funds—would no doubt please its 19th-century founder, A. W. Lee.

According to a posthumous biography "The Lee Papers," Mr. Lee argued that newspapers should be financially self-sufficient, so that they "could look any man or corporation or institution in the face and tell that man or corporation or institution to go to hell."

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